The Mortgage Professor: Blockchains will upend the home mortgage market

Blockchains will have a considerable effect on mortgage markets because they will reduce the costs and risks of originating mortgages, servicing them, consolidating them into securities, and transferring ownership of individual mortgages and mortgage securities. The difficult question is how long it will take, since the forces that will array themselves against mortgage-related blockchains are formidable.

The block part of a blockchain is a set of accounts connected to a transaction, including all assets and liabilities, which are recorded electronically, and to which only selected parties have access, though in some cases this could be the public. Viewing a single mortgage-financed home purchase as a block, the following parties may be involved: borrower, third-party property investor, originating lender, future servicer, home seller, Realtor, appraiser, title company, mortgage insurer, mortgage purchaser, Fannie Mae, Freddie Mac, FHA and the Consumer Financial Protection Bureau.

Under existing arrangements, each entity involved in the transaction keeps its own records and is in contact with only those participants with which it deals directly – for example, the appraiser is in contact with the lender. If the home purchase is a block, in contrast, all the information contributed by all the participants becomes part of the block. There is now one final error-free and tamper-proof source of information about the transaction instead of multiple sources scattered in the files and computers of the individual participants. All participants sign off on the validity of the information in the block, and they may be the only ones who have access to that information.

The chain part of a blockchain could be the linkage to another transaction in the same property, which would be a small chain. Alternatively, or in addition since a block can be in more than one chain, the chain could consist of blocks of other mortgage-financed purchase transactions where the associated mortgages are intended for sale to a particular buyer, such as Fannie Mae. This would be a much larger chain. A block might also consist of purchase transactions on which the servicing of the associated mortgage will be offered to prospective servicers. The design options are wide open.

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What are the benefits of blockchain? Information from multiple sources is made available to every participant but has to be entered only once. This eliminates duplication of effort, and the delays and errors that inevitably result from it. With all participants on the same page all the time, processing time is lower. The more participants there are in the transaction, the greater the benefit, which is why the home mortgage market is a prime candidate. The other side of that coin, however, is that more participants mean more potential sources of resistance to participation.

A mortgage blockchain also has substantial potential for improving the quality of decisions by incorporating decision aids, sometimes called "smart contracts," into the block. A block with the appropriate decision aids could attract borrowers by helping them decide how much to put down, what kind of mortgage to select, and the combination of interest rate and points that best meets their needs.

Another potential benefit of mortgage blockchains is the impetus they may provide to increased productivity in those segments of the market where it has lagged. This includes property appraisals, ownership transfers, and the recording and retrieval of information on property features, ownership and liens. In the blockchains that emerge in future years, these functions will look very different, though in the short term they constitute barriers that need to be overcome.

What has this to do with bitcoin? The connection is that the creator of bitcoin used the blockchain as a device for creating a self-regulating means of payment that had nothing to do with government. The bitcoin experience led others to realize that the blockchain device had many other possible uses. In particular, it had the potential for making complicated market structures, such as the home mortgage market, more efficient.

This does not mean that developers of mortgage blockchains will ignore the potential for creating means of payment on the side. Indeed, the two firms that have begun developing mortgage blockchains are both creating means of payment, called "tokens," in the process. It's tempting to describe this as printing the money you need to start a new business, but the developers do need a compelling story to make their tokens acceptable. The bitcoin story is that the total number of bitcoin that can be produced is limited. I will discuss the stories connected to the two new mortgage-related blockchains in another article.

ABOUT THE WRITER

Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.